1. International Economics
Li Yumei
Economics & Management School
of Southwest University

2. International Economics
Chapter 8
Trade Restrictions: Tariffs

3. Organization 8.1 Introduction
8.2 Partial Equilibrium Analysis of a Tariff
8.3 The Theory of Tariff Structure
8.4 General Equilibrium Analysis of a Tariff in a Small Country
8.5 General Equilibrium Analysis of a Tariff in a Large Country
8.6 The Optimum Tariff
Chapter Summary
Exercises

4. 8.1 Introduction International Trade Theories: Free Trade
They explain that free trade maximizes world output
(specialization) and benefits all nations (higher indifference
curve ).
In Practice: Trade Restrictions (or Protection )
All nations impose some restrictions ( such as tariffs,
non-tariffs ) or regulations on the free flow of international
trade to protect the domestic economy from the foreign
competition.
The most historically used trade restriction has been the tariff.

5. 8.1 Introduction
Tariff
Tariff is a tax or duty levied on the traded commodity as it
crosses a national boundary. It can be classified an import tariff
a duty on the imported commodity) and an export tariff (a duty
on the exported commodity).
The import tariff is more important than export tariff, here the most of the discussion is the import tariff
Export tariffs are often used by developing countries on their traditional exports to get better prices and raise revenues due to the ease of collection

6. 8.1 Introduction Tariff Types
Ad valorem tariff(从价税)
expressed as a fixed percentage of the value of the traded
commodity
Specific tariff (从量税)
expressed as a fixed sum per physical unit of the traded
Compound tariff(复合税)
A combination of an ad valorem and a specific tariff
Before and After Multilateral Trade System
See the following tables (data and case studies)

22. Developing Countries

35. 8.2 Partial Equilibrium Analysis of a Tariff
Partial Equilibrium Effects of a Tariff
Effect of a Tariff on Consumer and Producer Surplus
Costs and Benefits of a Tariff
Conclusion

36. Partial Equilibrium Effects of a Tariff
Tariff Partial Equilibrium Analysis is most appropriate a small country case
The tariff will not affect world prices and the rest of the
economy (price taker)
Partial Equilibrium Effects of a Tariff
See Figure 8.1
The nation is a small country
DX is the demand curve and SX is the supply curve
In the absence of trade, the equilibrium point E
Under free trade, the domestic production and consumption of commodity X
After a 100 percent ad valorem tariff on the imports of X, the domestic production and consumption of X

37. FIGURE 8-1 Partial Equlibrium Effects of a Tariff.

38. Partial Equilibrium Effects of a Tariff
Tariff Effects of Figure 8.1
After the tariff, the domestic production (production effect ) increases while the domestic consumption (consumption effect ) of commodity X decrease;
After the tariff, government revenue (revenue effect) increases and the trade volume (trade effect) decreases;
Conclusion
After the tariff in a small country case, production effect and revenue effect are the positive while the consumption effect and trade effect are negative.
The consumer’s income redistributes to the domestic producer and government.

39. Effect of a Tariff on Consumer and Producer Surplus
Consumer Surplus
Consumer surplus is the difference between what consumers
would be willing to pay for each unit of the commodity and what
they actually pay. Graphically, consumer surplus is measured
by the area under the demand curve above the going price.
Higher prices mean the smaller consumer surplus.
Producer Surplus
Producer surplus refer to the payment that need not be made in
long run in order to induce domestic producers to supply more
disadvantageous commodity with the tariff. The increase in
producer surplus also referred to as the subsidy of the tariff.
Higher prices mean higher producer surplus.

40. FIGURE 8-2 Effect of Tariff on Consumer and Producer Surplus.

41. Costs and Benefits of a Tariff
Consumer and producer surplus can be used to measure the costs and benefits of the tariff
After the tariff, the consumer surplus decreases while the producer surplus increases
The decreased consumer surplus includes four parts:
Production effect
Protection effect
Revenue effect
Consumption effect
Costs and Benefits of a Tariff
Costs: protection effect and consumption effect (deadweight loss)
Benefits: Production effect and Revenue effect

42. FIGURE 8-3 Partial Equilibrium Costs and Benefits of a Tariff.

43. Costs and Benefits of a Tariff
Conclusion
Income redistribution
Tariff redistributes income from domestic consumers (who pay
higher prices for the commodity) to domestic producers of the
commodity (which receive the higher price ) and from the
nation’s abundant factor (producing exportable goods) to the
nation’s scarce factor (producing importable goods)
Economic inefficiency
Tariff distorts the domestic resources to transfer from the most
efficient production of exportable commodities to the less
efficient production of importable commodities (deadweight
loss)
Case studies 8-3 and 8-4 (page )

44. Conclusion
Partial equilibrium analysis of a tariff utilizes the nation’s
demand and supply curves of the importable commodity and
assume that the domestic price of the importable commodity
rises by the full amount of the tariff. It measures the reduction
in domestic consumption, increase in domestic production,
reduction in imports, the revenue collected, and redistribution
of income from domestic consumers (who pay higher price for
the commodity) to domestic producers (who receive a higher
price) as a result of the tariff. A tariff leads to inefficiencies
referred to as protection cost or deadweight loss.

45. FIGURE 8-8 (Partial Equilibrium Effects of a Tariff in a Large Nation)
Partial Equilibrium effects of a Tariff in a Large Nation (appendix A8.1 page 260)
FIGURE 8-8 (Partial Equilibrium Effects of a Tariff in a Large Nation)

46. Explanation of Figure 8.8
SH refers to the home supply, SH+F refers to the total supply of X for the large nation;
With free trade, the intersection point B is the equilibrium point of DH and SH+F, PX=$2 and QX=50 (of domestic supply is 20X=AC, foreign supply is 30X=CB);
With a 50 percent ad valorem import tariff (T), the total supply will shift up by 50 percent and becomes SH+F+T. The new equilibrium point H , PX=$2.5 and QX=40 (of domestic supply is 25X=GJ, foreign supply is 15X=JH;

47. Explanation of Figure 8.8
Consumer surplus decreases: a+b+c+d, at the same time the nation’s government also collects e (terms of trade benefit) from foreign exporter ( because the nation is large nation, the smaller quantity of exports will be supplied at a lower price).
The Welfare of the Large Nation with tariff – uncertain
Net benefit: If e>b+d;
Net loss: If e<b+d;
No change: if e=b+d

48. Conclusion of Figure 8.8
One big difference from a small nation: the large nation can benefit from the terms of trade (because large nation can affect foreign export or world prices) while the small nation always incurs a net loss from a tariff equal to the protection cost or deadweight loss because the small nation does not affect foreign export or world price (e=0)
Although the large nation can benefit from the terms of trade, foreigners are likely to retaliate with a tariff of their own. In the end both nations are likely to lose from the reduced level of trade and international specialization

49. 8.3 The Theory of Tariff Structure
The Rate of Effective Protection
Generalization and Evaluation of the Theory of Effective Protection
Conclusion

50. The Rate of Effective Protection
Nominal Tariff & Effective Tariff
Nominal Tariff
It means the tariff on imports of a final commodity.
Effective Tariff
It means the tariff not only on imports of a final commodity
also on imports of raw materials or intermediate goods for the
production of a final commodity. Then calculating the real
protection effect.
The rate of effective tariff: calculated on the domestic value
added , or processing, that takes place in the nation exceeds
the nominal tariff rate (calculated on the value of the final
commodity)

51. The Rate of Effective Protection
The Formula of Effective Tariff
G=(t-aiti)/1-ai
G= the rate of effective protection to producers of the final commodity;
t=the nominal tariff rate on consumers of the final commodity;
ai= the ratio of the cost of the imported input to the price of the final commodity in the absence of trade;
ti= the nominal tariff rate on the imported input
Example page 245
Conclusion
Whenever the imported input is admitted duty free or a lower
tariff rate is imposed on the imported input than on the final
commodity produced with the imported input, the effective
rate of protection will exceed the nominal tariff rate.

52. Generalization and Evaluation of the Theory of Effective Protection
If ai=0,g=t (the effective protection equals the nominal protection);
Fore given values of ai and ti, g is larger the greater is the value of t;
Fore given values of t and ti, g is larger the greater is the value of ai;
The value of g exceeds, is equal to, or is smaller than t, as ti is smaller than, equal to, or larger than t;
When aiti exceeds t, the rate of effective protection is negative

53. FIGURE 8-4 Pre- and Post-Uruguay Round Cascading Tariff Structure in Industrial Countries.

54. The nominal tariff is deceptive Tariff Escalation
Conclusion
The nominal tariff is deceptive
Tariff Escalation
Cascading tariff structure in most industrial nations:
With very low or zero nominal tariffs on raw materials and
higher and higher rates the greater is the degree of processing.
Tariff escalation makes the rate of effective protection on a
final commodity with imported inputs much greater than the
nominal tariff rate would indicate.
Tariff Theory
The theory assumes that the international prices of the
commodity and of imported inputs are not affected by tariffs
and that inputs are used in fixed proportions in production.

55. 8.4 General Equilibrium Analysis of a Tariff in a Small Country
General Equilibrium Effects of a Tariff in a Small Country
Illustration of the Effects of a Tariff in a Small Country
The Stolper-Samuelson Theorem
Conclusion

56. General Equilibrium Effects of a Tariff in a Small Country
General equilibrium analysis is used to study the effects of a
tariff on production, consumption, trade, and welfare when the
nation is too small to affect world prices by its trading. There
are some assumptions as follows:
When a small nation imposes a tariff, it will not affect prices on the world market, the domestic price of the importable commodity will rise by the full amount of the tariff for individual producers and consumers in the small nation
As for the whole of the small nation, its price remains constant
The government of the small tariff-imposing nation uses the tariff revenue to subsidize public consumption and /or for general income tax relief

57. Illustration of the Effects of a Tariff in a Small Country
Figure 8.5 (page 250)
Nation 2’s PPF shows that it is a country with capital-abundance specializing in the production of commodity Y;
Under free trade, if PX/PY=1 on the world market, it produces at Point B exchange 60Y for 60X with the rest of the world, its consumption at Point E on its indifference curve Ⅲ;
With a 100 percent ad valorem tariff on imports of commodity X, the relative price of X rises to PX/PY=2 for domestic producers and consumers but at PX/PY=1 on the world market and for the nation as a whole. The domestic production is at Point F ( more production of importable X and less exportable Y). Its consumption at Point H’ ( but only 15 X for consumption, the remaining 15X is collect by the government in the 100 percent of import tariff on X)

58. FIGURE 8-5 General Equilibrium Effects of a Tariff
in a Small Country.

59. Illustration of the Effects of a Tariff in a Small Country
To summarize Figure 8.5
Production effect : More of importable goods and less of exportable goods
Consumption effect : lower consumption than free trade
Trade effect : the decrease of the trade volume
Welfare effect: higher tariff will lead to return to its autarky point A in production and consumption. The tariff is called a prohibitive tariff

60. The Stolper-Samuelson Theorem
Content
The theory postulates that an increase in the relative price of a
commodity raises the return or earnings of the factor used
intensively in the production of the commodity. Thus, the real
return to the nation’s scarce factor of production will rise with
the imposition of a tariff.
Explanation
Tariff on the imported labor-intensive commodity X, PX/PY rises
for domestic producers and consumers, and so the real wage of
labor.

61. The Stolper-Samuelson Theorem
Reason
Import Tariff on scarce factor of production more of
importable production and less of exportable production
the change of L/K ratio the earnings of the scarce factor
of production rises
This theory explains that the small nation as a whole is harmed by the tariff, its scarce factor benefits at the expense of its abundant factor

62. Conclusion When a small nation imposes an import tariff, the domestic
price of the importable commodity rises by the full amount of
the tariff for individuals in the nation. As a result, domestic
production of the importable commodity expands while
domestic consumption and imports fall. However, the nation as
a whole faces the unchanged world price since the nation itself
collects the tariff. These general equilibrium effects of a tariff
can be analyzed with the trade models developed in Part one
and by assuming that the nation redistributes the tariff revenue
fully to its citizens in the form of subsidized public
consumption and /or general income tax relief.

63. Conclusion
According to the Stolper-Samuelson theorem, an increase in the relative price of a commodity raises the return or earnings of the factor used intensively in its production. For example, if a capital-abundant nation impose an import tariff on the labor-intensive commodity, wages in the
nation will rise. On the contrary, if a labor-intensive nation impose an import tariff on the capital-intensive commodity, rents in the nation will rise.

64. 8.5 General Equilibrium Analysis of a Tariff in a Large Country
General Equilibrium Effects of a Tariff in a Large Country
Illustration of the Effects of a Tariff in a Large Country
Conclusion

65. General Equilibrium Effects of a Tariff in a Large Country
General equilibrium analysis is used to study the production,
consumption, trade and welfare effects of a tariff for a large
country case.
Large Country
It means it is large enough to affect the world price.
Offer curves
When a nation imposes a tariff, its offer curve shifts or rotates
toward the axis measuring its importable commodity by the
amount of the import tariff.
To reduce the volume of trade but improve the nation’s terms of trade
Nation’s welfare actually rises or falls depends on the net effect of trade volume and terms of trade

66. Illustration of the Effects of a Tariff in a Large Country
Figure 8.6
With free trade, the equilibrium point of two nations’ offer curves is at E ;
After the imposition by Nation 2 of a 100 percent ad valorem tariff on its imports of Commodity X is reflected in Nation 2’s offer curve rotating to offer curve 2’ , the tariff-distorted offer curve 2’ is at every point 100 percent or twice as distant from the Y-axis as offer curve 2 . The new equilibrium is at Point E’, Nation 2’s terms of trade improves (PX/PY=0.8) while Nation1’s deteriorates (PX/PY=1.25).
The steeper or less elastic Nation 1’s offer curve is , the more its terms of trade deteriorate and Nation 2’s improve

67. FIGURE 8-6 General Equilibrium Effects of a Tariff
in a Large Country.

68. Illustration of the Effects of a Tariff in a Large Country
For Nation 2 as a whole, the import 50X by Nation 2 at equilibrium point E’, 25X is collected in kind by the government of Nation 2 as the 100 percent import tariff on commodity X and only the remaining 25X goes directly to individual consumers.
Explanation of Figure 8.6
When large Nation 2 impose a tariff, the volume of trade declines but its terms of trade improve.
For individual consumers and producers in Nation 2, PX/PY=PD=1.6, or twice as much as the price on the world market and for the nation as a whole
Stolper-Samuelson theorem also holds in a large nation. If PX/PY falls, it is known as the Metzler paradox ( discussed in the appendix)

69. Conclusion
When a large nation imposes an import tariff, its offer curve rotates toward the axis measuring its importable commodity by the amount of the tariff, reducing the volume of trade but improving the nation’s terms of trade.
The Stolper-Samuelson theorem refers to the long run when all factors are mobile between the nation’s industries.
Stopler-Samuelson theorem explains the reason of tariff imposition in nations: Import tariff can increase the real returns of the nation’s scarce factor of production.

70. 8.6 The Optimum Tariff
The Meaning of the Concept of Optimum Tariff and Retaliation
Illustration of the Optimum Tariff and Retaliation
Conclusion

71. The Meaning of the Concept of Optimum Tariff and Retaliation
Optimum tariff is the rate of tariff that maximizes the net
benefit resulting from the improvement in the nation’s terms of
trade against the negative effect resulting from reduction in
the volume of trade.
Tariff Retaliation
As the terms of trade of the nation imposing tariff improve,
those of the trade partner deteriorate. As a result, the trade
partner is likely to retaliate and impose an optimum tariff on its
own. If the process continues, all nations usually end up
losing all or most of the gains from trade. The world as a
whole is worse off than under free trade.

72. Illustration of the Optimum Tariff and Retaliation
FIGURE 8-7 The Optimum Tariff and Retaliation.

73. Conclusion
The nation’s benefit comes at the expense of other nations, the latter are likely to retaliate, so that in the end all nations usually lose;
An optimum tariff for a small country is zero (since a tariff will not affect its terms of trade and will only cause the volume of trade to decline (Figure 8.6 points E and H’). No tariff can increase the small nation’s welfare over its free trade position even if the trade partner does not retaliate;
An optimum tariff for a large country is easy to arouse tariff retaliation.

74. Chapter Summary
Tariff imposition has four effects: production effect, protection effect, revenue effect consumption;
Tariff reduces the nation’s welfare and leads to the decline of trade volume;
Tariff can increase the returns of the domestic scarce factor of production (Stolper-Samuelson);
Tariff is easy to arouse the retaliation .

75. Exercises
Discussion Problems:
Page 258 to 259 from 1 to 14 questions

76. Exercises Additional Reading
Comprehensive surveys of trade policies, in general, and the
theory and measurement of tariffs, in particular, are:
W.M.Corden, The Theory of Protection (London: Oxford University Press, 1971)
J.N.Bhagwati, in R.C.Feenstra, ed., The Theory of Commercial Policy (Cambridge, Mass.: MIT Press, 1983)
J.N.Bhagwat, Protectionism (Cambridge, Mass.: MIT Press, 1988)
For measures of the cost of protection, see:
G.H.Hufbauer, D. T. Berliner, and K. A.Elliott, Trade Protection in the United States: 31 Cases (Washington, D.C.: Institute for International Economics, 1986)

77. Internet Materials